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Demand, Supply, and Market Equilibrium Chapter 3 Demand, Supply, and Market Equilibrium Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Demand, Supply, and Market Equilibrium 3 Chapter Outline Firms and Households: The Basic Decision-Making Units Input Markets and Output Markets: Equilibrium The Circular Flow Demand in Product/Output Markets Changes in Quantity Demanded versus Changes in Demand Price and Quantity Demanded: The Law of Demand Other Determinants of Household Demand Market Shift of Demand versus Movement along a Demand Curve From Household Demand to Market Demand Supply in Product/Output Markets Price and Quantity Supplied: The Law of Supply Other Determinants of Supply Shift of Supply versus Movement along a Supply Curve From Individual Supply to Market Supply Market Equilibrium Excess Demand Excess Supply CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER Changes in Equilibrium Demand and Supply in Product Markets: A Review Looking Ahead: Markets and the Allocation of Resources © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 46 FIRMS AND HOUSEHOLDS: THE BASIC DECISION-MAKING UNITS firm An organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. Equilibrium entrepreneur A person who organizes, Market manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. households The consuming units in an economy. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 46 INPUT MARKETS AND OUTPUT MARKETS: THE CIRCULAR FLOW product or output markets The markets in which goods and services are exchanged. Equilibrium input or factor markets The markets in Market which the resources used to produce products are exchanged. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 46 INPUT MARKETS AND OUTPUT MARKETS: THE CIRCULAR FLOW Equilibrium Market CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER FIGURE 3.1 The Circular Flow of Economic Activity © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 46 INPUT MARKETS AND OUTPUT MARKETS: THE CIRCULAR FLOW labor market The input/factor market in which households supply work for wages to firms that demand labor. Equilibrium capital market The input/factor market in which households supply their Market savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 46 INPUT MARKETS AND OUTPUT MARKETS: THE CIRCULAR FLOW land market The input/factor market in which households supply land or other real property in exchange for rent. Equilibrium factors of production The inputs into the production process. Land, labor, and Market capital are the three key factors of production. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER Input and output markets are connected through the behavior of both firms and households. Firms determine the quantities and character of outputs produced and the types of quantities of inputs demanded. Households determine the types and quantities of products demanded and the quantities and types of inputs supplied. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS A household’s decision about what quantity of a particular output, or product, to demand depends on a number of factors including: Equilibrium price of the product ■ The in question ■ The income available to the household amount of accumulated ■ The household’s Market wealth prices of other products ■ The available to the household ■ The household’s tastes and preferences expectations ■ The household’s about future income, wealth, and prices CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS quantity demanded The amount (number of units) of a product that a Equilibrium household would buy in a given period if it could buy all it wanted at the current Market market price. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS CHANGES IN QUANTITY DEMANDED VERSUS CHANGES IN DEMAND The most important relationship in Equilibrium individual markets is that between market price and quantity demanded. Market Changes in the price of a product affect the quantity demanded per period. Changes in any other factor, such as income or preferences, affect demand. Thus, we say that an increase CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER in the price of Coca-Cola is likely to cause a decrease in the quantity of Coca-Cola demanded. However, we say that an increase in income is likely to cause an increase in the demand for most goods. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS PRICE AND QUANTITY DEMANDED: THE LAW OF DEMAND demand schedule TABLE 3.1 Anna’s Demand Schedule for Telephone Calls Equilibrium A table showing how QUANTITY DEMANDED much of a given PRICE (PER CALL) (CALLS PER MONTH) product a household $ 0 30 Market would be willing to .50 25 buy at different 3.50 7 7.00 3 prices. 10.00 1 15.00 0 CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS demand curve A graph illustrating how much of a given product a household would be willing to buy at different prices. Equilibrium FIGURE 3.2 Anna’s Demand Curve Market CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS Demand Curves Slope Downward law of demand The negative relationship between price and quantity Equilibrium demanded: As price rises, quantity demanded decreases. As price falls, quantity demanded increases. Market CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER It is reasonable to expect quantity demanded to fall when price rises, ceteris paribus, and to expect quantity demanded to rise when price falls, ceteris paribus. Demand curves have a negative slope. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS Other Properties of Demand Curves Two additional things are notable about Anna’s demand curve. Equilibrium As long as households have limited incomes and wealth, all demand curves will intersect the price axis. For any commodity, there is always a price above which a household will not, or cannot, pay. Even if the good or service is very important, all households Market are ultimately constrained, or limited, by income and wealth. That demand curves intersect the quantity axis is a matter of common sense. Demand in a given period of time is limited, if only by time, even at a zero price. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS To summarize what we know about the shape of demand curves: 1. They have a negative slope. An increase in price is likely to lead to a decrease in Equilibrium quantity demanded, and a decrease in price is likely to lead to an increase in quantity Market demanded. 2. They intersect the quantity (X-) axis, a result of time limitations and diminishing marginal utility. 3. They intersect the price (Y-) axis, a result of limited incomes and wealth. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS OTHER DETERMINANTS OF HOUSEHOLD DEMAND Income and Wealth income The sum of all a household’s Equilibrium wages, salaries, profits, interest payments, rents, and other forms of earnings in a Market given period of time. It is a flow measure. wealth or net worth The total value of what a household owns minus what it owes. It is a stock measure. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS normal goods Goods for which demand goes up when income is higher and for which demand goes down when income Equilibrium is lower. inferior goods Goods for which demand Market tends to fall when income rises. CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS Prices of Other Goods and Services substitutes Goods that can serve as replacements for one another: when the Equilibrium price of one increases, demand for the other goes up. Market perfect substitutes Identical products. complements, complementary goods Goods that “go together”: a decrease in the price of one results in an increase in CHAPTER 3: Demand, Supply, and Supply, Demand,3: CHAPTER demand for the other, and vice versa. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 46 DEMAND IN PRODUCT/OUTPUT MARKETS Perfect substitutes? On a hot day in the desert, one brand is Equilibrium as good as another.
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